Construction Contracts 101

Reviewing the contract documents for a complex construction project can seem like a daunting task given the volume of information they contain.  Often spanning hundreds to thousands of pages, it is helpful to understand the key items that a construction contract needs to contain to make the contract easier to review and implement.  This article breaks down the main components of construction contracts so that practitioners know what to look for when reviewing a construction agreement and when attempting to resolve disputes that arise under the contract.

There are two primary categories comprising construction agreements: namely, the commercial components and the technical components.  The commercial components address matters such as the timing of work, payment terms and conditions, responsibility for different aspects of the work, provisions for changes and relief, and perhaps most importantly, the contractual risk allocation.  Meanwhile, the technical components of a contract speak to items such as the scope of work, guidelines and requirements for design and construction, required standards and specifications, work constraints and limitations, conceptual designs, and other technical materials that govern what is build and how.  It is important to understand that each of these elements may go by different nomenclature depending on the project owner and type, but generally speaking, construction agreements contain similar information.

Below is a description of the different components of a construction contract:

Agreement:

The Agreement is the contractual document signed by the parties that contains the commercial structure of the parties’ relationship.  The Agreement will generally contain the following items:

• Identity of the parties: the formal naming of the owner and contractor;
• Identity of the project: the contract will identify the project, though the description of the project’s scope may be contained in the technical requirements and design documents;
• Identification of the incorporated documents: the Agreement will specify other documents that are incorporated by reference into the contract, thereby making them binding on the parties;
• Order of precedence: the Agreement will specify which documents take precedence if there is a conflict between the different documents that make up the contract;
• Payment terms: stating how often the contractor gets paid, the method of payment, the invoicing requirements, and process for measurement of payment.  For example, if the contract is a lump-sum agreement, the contract will usually state that the contractor is paid based on the amount of work complete, whereas a unit price contract will specify that the contractor is paid based on units of work performed during the payment period, and a time and materials contract will specify that the contractor is paid based on the measured quantities of labor, equipment, materials, and overhead expended;
• Responsibility for the site during the work: the Agreement will state how the contractor is required to maintain the worksite and the timing of the contractor’s obligations;
• Right-of-way/access: the Agreement will identify the boundaries of the site and when the contractor can expect to have access.  The Agreement may also state what the contractor must do if there is a delay to the expected access to the site.
• Site conditions: the contractor’s obligations with respect to site conditions and provisions governing the contractor’s response if it encounters an unexpected or unidentified condition.  These provisions may also state how the contractor must proceed if it identifies hazardous materials.
• Third-party interaction: the contractor’s obligations with respect to third-parties, such as necessity for receipt of approvals and permits, interaction with utility owners, and other required input.
• Insurance and bonding: the insurance policies and bonds that the contractor must furnish as part of the work.
• Contract price: the price that the contractor will receive for performing the work, as well as the type of payment, such as fixed price lump-sum, unit price, or time and materials.
• Completion deadlines: the time in which the contractor must finish the work.  Completion deadlines may be broken down into a substantial completion deadline and final completion deadline, as well as establish interim or other milestones and deadlines.
• Relief events: the events that would allow the contractor to obtain an adjustment to the contract price or completion deadlines.  An Agreement may either contain specific events or a general clause allowing for an adjustment when circumstances occur that are beyond the contractor’s control.  These provisions may also contain limitations on the type of relief available, such as limiting the types of relief to which the contractor is entitled when certain relief events occur.  The relief events and their limitations generally represent the contractual risk allocation, as the presence of a relief event for a specified occurrence means that the owner bears the risk of the event while the absence of a relief event or limitations on one mean that the contractor bears the risk of the occurrence.
• Mitigation: A general requirement that the contractor must mitigate its damages when a relief event occurs.
• Change orders: The process for making changes to the contract.  Change orders encompass unilateral and bilateral changes to the work, as well as price and schedule adjustments due to the occurrence of relief events.  The process will specify the notice and information required to establish entitlement to a contract adjustment, as well as the process for submission and resolution.
• Dispute resolution: A process for resolving disputes when the parties cannot agree on whether the contractor is entitled to a change order.  On smaller projects, this may be as simple as allowing the parties to take a dispute to mediation, arbitration, or litigation, while larger projects may have a project-specific forum for dispute resolution before a dispute can be resolved through external mediation, arbitration, or litigation.
• Warranty: the warranty provisions after completion of the work, which provide the contractor’s responsibilities for repairing work for a specified duration.
• Suspension and termination: the process for suspension or termination of the work, including events of default.  These provisions will also specify compensation when there is a suspension or termination.
• Remedies:  The available remedies for breach of the Agreement.  These provisions may also contain limitations on available remedies, such as precluding consequential or punitive damages, or limiting liability.  The remedies available to the owner may also include liquidated damages in certain situations, such as late completion of the project.
• Document retention: the requirements for maintenance of records both during and after completion of the project.
• Miscellaneous: standard contract language, such as third-party beneficiaries, severance, choice of law, venue and forum for litigation, non-waiver, notice provisions, and other boilerplate terms.

Technical Requirements

The technical requirements contain the scope of work that the contractor is required to perform.  These requirements will vary significantly depending on the project delivery method:

• Design-Bid-Build: in the traditional delivery method, the technical requirements primarily consist of the final design on which the contractor bid.  The technical requirements will also contain other standards for performance of the work, including work restrictions, third-party requirements, and other information that governs how the contractor must perform construction.  The technical requirements will also provide requirements for items such as quality, safety, maintenance of traffic, and the process for field changes.  These requirements may incorporate other standards, such as AASHTO for roadway, AASHTO LRFD for bridges, AREMA for railway, and other similar types of design and construction standards.  For infrastructure work, the technical requirements are often the owner agency’s standard specifications and special provisions that provide requirements specific to the project.

• Design-Build: the technical requirements will generally include a concept to 30% level design and performance and prescriptive specifications that govern completion of the final design and construction work.  These requirements will include everything applicable to the project, including parameters for items such as structures, drainage, utilities, aesthetics, roadway, lighting, quality, safety, and other relevant items.  These requirements, like design-bid-build, may include referenced standards that govern portions of the work.  For infrastructure work, the technical requirements may be a modified version of the owner’s standard specifications that contain performance-based requirements in place of prescriptive specifications.

• CM/GC: on these types of projects, there will be a mix of information depending on the status of the project when the contractor is procured.  The initial preconstruction agreement may contain general technical requirements that shape how the contractor will provide input to the owner and designer, including the parameters that will apply during the construction work.  The construction contract will include the design on which the contractor bid plus the finalized specifications for performance of construction, which will include the items found on traditional design-bid-build projects.

• Progressive Design-Build: similar to design-build, a progressive design-build agreement will contain technical parameters that govern the final design and construction to be performed by the design-builder.  The difference between progressive design-build and standard design-build is that the requirements may not be as specific in the former to allow the design-builder sufficient latitude to innovate and to work with the owner to develop a mutually-agreeable approach to the work.

Reference Information

In addition to terms and conditions and technical requirements, construction documents may include reference materials that provide information about the project, the site, third-parties, and other relevant information.  Typically, reference materials are provided in the Request for Proposals and are not part of the contract itself.  However, it is often the case that certain reference materials are incorporated into the contract either directly or indirectly.

Direct incorporation of reference materials occurs when the technical requirements state that an item of work must be performed in accordance with information that is contained in the reference documents.  For example, the contractual technical requirements may require that a particular aspect of the design or construction comply with certain plans included in the reference materials.  Reference materials may include information submitted to permitting agencies and may contain the information on which issuance of a permit is based, which then requires the contractor to meet those conditions.

Indirect incorporation of reference materials occurs when a contractual item relies on reference documents.  For example, the contract may contain a relief event for differing site conditions that allows for a price and schedule adjustment when the site differs from the baseline conditions.  If the reference documents contain information about the condition of the site and the contractor based its bid on those documents, then the determination of whether a differing site condition exists will depend on whether the actual conditions vary from what was shown in the reference information.

Conclusion

Understanding the basic components of a construction contract is the first step toward interpreting a complex web of the terms and conditions to which a project owner and contractor are bound.  The contract is the fundamental description of the relationship between the parties, and it is vital to understand each party’s obligations and limitations on what they can do.  Moreover, understanding how construction contracts operate is a key part of minimizing the potential for disputes by ensuring that project team members know the bounds in which they operate.